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Treasury yields are screaming lower. And although the stock market made a significant correction yesterday, the yield curve is still showing signs of extreme credit dislocations.
Curve Watcher’s Anonymous is noting something unusual today. Let's take a look.
click on chart for sharper image
Note that treasuries are staging a big rally on the front end and back end while selling off slightly in the middle. Somewhere there is a big duration mismatch. Alternatively there is a mad scramble by players wanting to get in on the deflation trade.
The second thing noteworthy is yields on T-Bills. Prior attempts at this level have not held, but should we close here (and it is by no means certain), this will be the lowest close ever at the short end of the curve.
Note: In the brief time that it took to finish the post, yields are now headed lower across the board but the very long end and very short end are still outperforming the middle of the curve. 3-month T-Bill yields are at .61% and falling.
For more implications on excessively low short term yields please see Negative Yields On Treasury Funds.
This could be premature, but efforts to increase liquidity seem to be failing already. Let's recap actions to date.
Recap Of Fed Sponsored Facilities
- The TAF (Term Auction Facility) failed to restore liquidity.
- The TSLF (Term Securities Lending Facility) failed to restore liquidity. See The Fed's Swap Meet for more on the TSLF.
- The PDCF (Primary Dealer Credit Facility) will be the next "facility" to fail. See Fed Fails To Halt Debt Meltdown for more on the PDCF.
Treasuries Are Safer Than Cash
I had an email exchange with a reader yesterday who said "Deflationists don't generally believe in buying gold, because they believe cash is king". The same person was also questioning a statement I made about cash losing value in deflation. Let's take a look at these ideas starting with cash.
While cash may be king, and I have made that statement many times myself, it is only king if it cannot be defaulted on. Cash in the bank, above the FDIC limit, can indeed be defaulted on. Also note that money markets are at risk if they are invested in mortgage backed securities instead of treasuries.
The only guaranteed safe way to hold cash is in amounts below the FDIC limit. Above the FDIC limit, cash is not king and cannot safely be held as cash but must instead be parked in US Treasuries. Realization of this simple fact is likely behind the huge rally on the short end of the curve.
How Cash Can Lose In Deflation
- Cash may be worth less in term of other currencies.
- Cash may be worth less in terms of gold.
- Cash (above the FDIC limit) can be defaulted on.
As for gold, there are many deflationists who believe gold is money and money will do well in deflation. I am one of them.
However, I have also said that gold would likely correct because leverage in hedge funds would have to be unwound and some of that leverage is in gold. Also there are many who have piled into gold for the “wrong” reason. The wrong reason is inflation. Please see Now Presenting: Deflation! for an analysis of the inflation situation.
Unlike cash in the bank or US Treasuries, gold is the only currency that is no one’s liability. Government decree alone cannot stop gold from being money. Gold’s role as money has held throughout history.
Long term the US dollar is headed to zero, so is the Yen, and so is the Euro. All fiat currencies eventually go to zero. Gold will never go to zero.
However, the long term is a long time. The dollar is not headed to zero tomorrow, nor is the Yen, nor is the Euro. Right now, a flight to the safety of treasuries is underway as leverage elsewhere is forced out of the system. This is just what one would expect to see happen as deflation picks up steam.
Mike "Mish" Shedlock
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